Bhalla makes a number of points:
- Our exports may have grown at around 20% over the past few years. But Indian exports have underperformed those of other Asian economies. Rupee appreciation will deepen underperformance.
- The RBI's intervention in the exchange market through purchase of dollars entails a cost. This is because the return on the dollars so purchased is about 5% while the return on the rupee is 8%- we lose 3% on the dollars invested. Many argue that this is one reason why the RBI should not intervene as much as it has done in the past. Bhalla disagrees. He says that by not intervening, the rupee appreciates. The cost of rupee appreciation is much greater. Every 10%t of depreciation, he estimates, costs us 2% of GDP or $20 bn. The loss on accumulated reserves is much lower -$600 mn. So, it is much better to bear the cost of intervention than to keep the rupee from depreciating.
I' m not persuaded. Our overall growth performance is next only to China's. We should worry about exports only if overall growth disappoints. All indications are that improvements in productivity and profitability in Indian business have been deep enough for exporters to withstand the kind of appreciation we have seen.
Secondly, intervention in the forex market has become very difficult in the face of kind of inflows we are facing. It leads to huge injection of liquidity which fuels inflation. Rupee appreciation, in contrast, is a useful instrument in battling a high rate of inflation.
Thirdly, by intervening and keeping the rupee from appreciating, the RBI encourages greater inflows- there is no cost to those who borrow abroad. You need a period of appreciation to get players to understand that they cannot indulge in a one-way bet and keep bringing in dollars.
The bottomline: we are well past the days when the exchange rate could be managed in a narrow band.
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